Has Quantitative Easing Backfired?

The vast majority of central banks have been embarking on some form of quantitative easing over the last couple of years. But the economic outlook for most of the world is being repeatedly cut.

This calls into question whether the policy is as effective as its proponents claim. As central banks plunge further into negative rates, it seems to be an increasingly relevant issue.

Proponents of quantitative easing – chief among them the IMF – could argue that what little economic growth we have is thanks to the policy. They could argue that things would be a lot worse without central bank easing.

They can even point to the mountains of traditional economic theory to support their position.

The Rebels

The group who argue for a change in policy and warn about the potential shortcomings of QE have some interesting allies. That is, the many members of the governing boards of the very central banks buying securities.

Calling for structural change and saying that the central bank can’t be solely responsible for reviving economic growth is a cliche at this point. But the calls have become more pronounced as the economies with the most accommodative central banks have failed to take off.

Meanwhile, the largest economy in the world – where the President is notoriously at odds with financial regulators – has record economic performance.

So, What Are the Cons of Quantitative Easing?

There is still a consensus that QE in the immediate instance of a financial crisis is useful.

Where the difference comes in is the effect of “prolonged” QE. Dissenters have likened it to an addictive drug.

It’s supposed to get a jolt of adrenaline to a lagging economy. But, financial institutions can become complacent towards injections of cheap capital to prop up bond and stock markets.

Everyone also agrees that QE has negative consequences. Low interest rates are meant to discourage savers, which means retirement funds deplete quicker, affecting the most vulnerable.

The longer QE is in place, the more the effect persists. This leads to potential bankruptcy in retirement systems, forcing up retirement ages and cutting benefits.

Conditions Aren’t the Same

The argument initially was that lowering rates or buying securities, would be a short-term policy. This would then minimize the negative effects, and the “price” would be worth paying.

The thing is, in the interim, studies have shown that the increased liquidity of QE doesn’t necessarily go where the central bank wants.

Carry trade encourages the migration of funds overseas in search of higher yields. Faced with a lack of investment returns, many savers simply hoard cash. Neither helps growth in the domestic market, even if it helps reduce the potential of inflation.

Some have argued that the massive increase in wealth inequality is due to QE. They claim it supplies cheap capital to the largest businesses and financial institutions, while the low interest rate discourages banks from offering riskier loans to small businesses.

One can point to increasing income inequality in countries with extended QE programs, such as Japan and now the EU.

Coincidence

Naturally, the situation could be a case of “correlation does not mean causation”.

QE is supposed to be applied when economic conditions are poor. But what if the economic conditions are caused by QE? With central banks continuing to cut rates, it doesn’t seem to be a question regulators are considering too much.